About 11 years ago, the Towers Watson’s Thinking Ahead Group came up with the concept of investors appointing managers for 10-year mandates. The consulting arm then started talking to clients about it in 2004/05 and the early mandates have now matured. So did it work? Do longer-term mandates produce outperformance, better behaviour and more security? Amanda White spoke to the founder and chief executive of the Thinking Ahead Group at Towers Watson, Tim Hodgson.
The answer, at least in concept, is yes 10-year mandates produce better results.
But probably the biggest learning, and benefit, from the Towers Watson experience is that there are still behaviours, and relationships, that are constraining the success of long-term mandates.
Tim Hodgson, who heads up the Thinking Ahead Group, says that Towers Watson put together a model portfolio of long-term managers, a paper portfolio that performed very well.
“The performance of that portfolio has been very good, and this long-term mandate model portfolio proves you can find good long-term managers,” he says.
“But what we learnt this first time round is that in practice clients usually appointed one manager, not a portfolio of mangers, so they got a more volatile experience.”
He says that in the lead up to the GFC the relative performance of some long-term mandates was painful, because growth and momentum was strong.
“But if clients stuck to it then value bounces back,” he says.
“Over 10 years there is an incremental advantage. But what we’ve learnt is that not all clients are able to stick to the course, this is usually for the normal reasons like decision making, governance, accountability.”
Hodgson and his colleagues are taking these learnings and writing a paper, Long-term mandates 2.0, which outlines for investors the pillars for success.
“We have learnt from 1.0 that we still believe in long-term mandates but we need to learn how to deliver a better experience – part of that is to have a portfolio of long-term mandates.”
He says there was a very large spread between the best and worst managers in the model portfolio, but as a portfolio it has done very well, performing an average 2 per cent per annum above a world index.
The three pillars of success, Hodgson says, are:
- Laying the foundations. This includes setting up the fund for success and adequately addressing the mindset, governance, processes, and work necessary to ensure the decisions can be stuck out.
- Designing and negotiating the mandate
- Monitoring and living with the mandate
“We learnt that yes everyone signed up to a CPI plus x per cent but when it comes to living with it they want to compare it to a world index. It is an absolute return concept but people still want to do the usual quarterly checking.”
The Thinking Ahead Group is also assessing the design of the mandate. For example does a long-term mandate have to be pure listed equities? Do you allow listed equities mandates to include bonds? Can a mandate be redesigned to include illiquid mandates and listed equities? Would a multi-asset product be appropriate? How do you treat cash?
In addition Hodgson believes that if the design of a long-term mandate is on the drawing board then time diversification should be part of the conversation.
“Anyone who thinks good long term returns are about chain linking above average annual returns doesn’t understand the problem,” he says.
The thinking incorporates VUCA – and the existence of volatile, uncertain, complex and ambiguous conditions.
“You can’t be excellent in every period and link them. You could allow for very big swings. Just because you set up as long term animal doesn’t’ mean you can’t act in the short term.”
The hope is that version 2.0 of long-term mandates, incorporates room to move on fee negotiation.
The concept is that the mandate has longer lockups so managers should discount their fees. This didn’t work the first time around, in part because the lockups turned out to be more theory than practice. Not every asset owner could go the duration of the mandate.
In addition Towers Watson had to dip into a different pool of managers outside the usual institutional investment management pool.
“We went to the family office managers, who were used to managing a private pool of money where a client says ‘I’ve worked hard to build the business and do not lose my money’.”
Despite the teething problems encountered with 10-year mandates, Hodgson believes they will succeed.
“It is a more intelligent frame of reference,” he says. “Certain behaviour might be good for profits this quarter but long-term mandates force the consideration of whether there are long term implications.”